Master the Markets

Tom Williams, a veteran trader and author of this work, has been energetically applying his expertise to profit from the stock and futures markets for the past 45 years. Williams spent 12 years in Beverley Hills, California, working with an off-the-floor professional trading syndicate to reap huge rewards for their own (and private) accounts.

Tom is the father of the Volume Spread Analysis TM (VSA) methodology, which is a creative set of market timing indicators that will enable you to confirm your entries (and exits) in today’s fast-paced financial markets. By using his techniques, you will have a significant advantage over the average trader or investor.

Tom also designed the VSA TM computer software, which later became the foundation for the popular TradeGuider software.

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AcknowledgementThis book is the product of a great deal of research, reflection, and a realisation that the financial markets cannot beencapsulated by a single, unified mathematical formula, or collection of mathematical formulae.My personal development would not have been the same without the help, support, and pooling of knowledge withothers over the years. Prominent among these people is Tom Williams, a veteran trader who is now 77 years old.He is a fascinating man, with an enviable knowledge of market mechanics and was the first trader to open my mindto the real workings of the financial world. Tom has an intimate understanding of what really goes on behind thescenes, in professional circles, owing to his 12-plus years experience in Beverley Hills, California, working with atrading syndicate (off the floor stock traders).Williams is a brilliant analyst, with a very different thinking from all other public personalities in the trading world.Some would say that Tom is a genius, and due to his extensive knowledge of the markets, his innovative theoriesand faultless comprehension, I am inclined to agree with this opinion.The VSA trading software was created in the early 1990’s, as a result of his aspiration to pass on his knowledge tohelp other traders. Through his seminars in the UK and his book, “The Undeclared Secrets That Drive the StockMarket”, Tom realised his ambition to help the next generation of traders.Williams has been instrumental in my understanding of the markets, and has spent many long hours, patientlyexplaining how the markets work, and how they are ultimately designed to cause the uninitiated to lose money. Iowe a large debt of gratitude to him, for ‘lifting the veil’ on the tricks and tactics practised by the market-makersand other professional players, who use a multitude of methods to profit from the unwary.If you are interested in the markets, you will find the contents of this book immensely interesting. Unlike manyother books, you will find the ideas presented herein difficult to dispute – they make sense and are based on hardfacts, rather than abstract theories!I hope that after reading this book that you feel just as excited as I was about the prospects of trading in a moreprofessional manner. There is a significant amount of information in this book that will help you take your tradingand investing to the next level. My advice is to take your time whilst reading this book and concentrate on thevarious definitive moves to look out for – try to imagine what is really happening behind the scenes. It takes a bit oftime to take onboard these new ideas, but I can promise that disciplined study and observation will reap rewards.If you have always felt that there is something missing in your understanding of how things fit together, this bookhas been written for you. I sincerely hope that you enjoy being initiated to a new level of awareness! ROY DIDLOCK President, TradeGuider SystemsMaster the Markets 3

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Preamble The Volume Spread Analysis (VSA) Methodology and TradeGuider Our proprietary Volume Spread AnalysisTM technology is used to generate the indicators in TradeGuider™. All of the charts in this book were taken from the TradeGuider or VSA software (the forerunner to TradeGuider). In order to maintain the continuity, meaning, and relevance of the original text, we have chosen to keep the original (VSA) illustrations in some parts of the book, as reference is made to various points on the charts for teaching purposes. This book is your foundation course in the Volume Spread Analysis™ (VSA™) methodology, which takes a multi-dimensional approach to analysing the market, and looks at the relationship between price, spread, and volume. For the correct analysis of volume, one needs to realise that the recorded volume information contains only half of the meaning required to arrive at a correct analysis. The other half of the meaning is found in the price spread. Volume always indicates the amount of activity going on, the corresponding price spread shows the price movement on that volume. This book explains how the markets work, and, more importantly, will help you to recognise indications as they occur at the live edge of a trading market – indications that a pit trader, market-maker, specialist, or a top professional trader would see and recognise. Volume Spread Analysis seeks to establish the cause of price movements, and from the cause, predict the future direction of prices. The ‘cause’ is quite simply the imbalance between Supply and Demand in the market, which is created by the activity of professional operators. The effect is either a bullish or bearish move according to the prevailing market conditions. We will also be looking at the subject from the other side of the trade. It is the close study of the reactions of the Specialists and Market-Makers which will enlighten you to future market behaviour. Much of what we shall be discussing is also concerned with the psychology of trading, which you need to fully understand, because the professional operator does and will take full advantage of it wherever possible. Professionals operating in the markets are very much aware of the emotions that drive YOU (and the herd) in your trading. We will be looking at how these emotions are triggered to benefit professional traders and, hence, price movements.Master the Markets 8

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Introduction The Largest Business in the World Every working day, billions of dollars exchange hands in the worlds stock markets, financial futures and currency markets. Trading these markets is by far the largest business on the planet. And yet, if you were to ask the average businessman or woman why we have bull markets or why we have bear markets, you will receive many opinions. The average person has absolutely no idea what drives the financial markets. Even more surprising is the fact that the average trader doesn’t understand what drives the markets either! Many traders are quite happy to blindly follow mechanical systems, based on mathematical formulas that have been back-tested over 25 years of data to ‘prove’ the system’s predictive capacity. However, most of these traders have absolutely no idea whatsoever as to the underlying cause of the move. These are intelligent people. Many of them will have been trading the financial markets, in one way or another, for many years. A large number of these traders will have invested substantial amounts of capital in the stock market. So, despite financial trading being the largest business in the world, it is also the least understood business in the world. Sudden moves are a mystery, arriving when least expected and appearing to have little logic attached to them. Frequently, the market does the exact opposite of a traders intuitive judgement. Even those who make their living from trading, particularly the brokers and the pundits, whom you would expect to have a detailed knowledge of the causes and effects in their chosen field, very often know little about how the markets really work. It is said that up to 90% of traders are on the losing side of the stock market. So perhaps many of these traders already have the perfect system to become very successful – all they need to do is trade in the opposite direction to what their gut feeling tells them! More sensibly, this book will be able to help you trade intuitively, but in a way a professional does. Below is a brief series of questions – as an experiment, see if you can answer any of them: • Why do we have bull markets? • Why do we have bear markets? • Why do markets sometimes trend strongly? • Why do the markets sometimes run sideways? • How can I profit from all of these movements? If you can answer these questions with confidence you do not need to read this book. If on the other hand you cannot, do not worry because you are not alone, and you will have the answers by the time you have reached the end of the book.Master the Markets 9

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It is interesting to note that the army puts a great of effort into training their soldiers. This training is not only designed to keep the men fit and to maintain discipline, but is designed around drills and procedures learned by rote. Drills are practised repeatedly until the correct response becomes automatic. In times of extreme stress which is encountered in the haze of battle (trading in your case), the soldier is equipped to quickly execute a plan of evasive action, suppressing fear and excitement, ensuring a correct response to minimise or eradicate whatever threat the soldier is exposed to. Cultivating this automatic and emotionless response to danger should be your mission too. Good traders develop a disciplined trading system for themselves. It can be very sophisticated or very simple, as long as you think it will give you the edge you will certainly need. A system that is strictly followed avoids the need for emotion, because like the trained soldier, you have already done all the thinking before the problems arrive. This should then force you to act correctly while under trading duress. Of course, this is easy to say, but very difficult to put into practice. Remember, trading is like any other profession, insofar as the accumulation of knowledge is concerned, but this is where the similarity stops. Trading is a rite of passage – the road will be long, the terrain will be tough, you will suffer pain. Trading is not glamorous! At this juncture, you do not need to worry about any of these things. This book will act as your ‘brief’, ‘intelligence report’, and ‘operations manual’. Read through the whole of this book – it will serve you well. You may not agree with all of the content, but that is not important – if you have absorbed the principles, the purpose of this book will have been fulfilled. As you gain more experience, you will see that the markets do in fact move to the dictates of supply and demand (and little else). Imbalances of supply and demand can be detected and read in your charts, giving you a significant advantage over your peers. If you own the TradeGuider software, you will see that it does an excellent job of detecting these key imbalances for you, taking the hard work out of reading the markets, and enabling you to fully concentrate on your trading.Master the Markets 10

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Random Walks & Other Misconceptions To most people, the sudden moves seen in the stock market are a mystery. Movements seem to be heavily influenced by news and appear when least expected; the market usually does the exact opposite to what it looks like it should be doing, or what your gut feeling tells you it ought to be doing. Sudden moves take place that appear to have little to do with logic: We sometimes observe bear markets in times of financial success, and strong bull markets in the depths of recession. It seems a place for gamblers, or for those people that work in the City, or on Wall St – who must surely know exactly what is going on! This is a fallacy. If you can take a little time to understand the contents of this book, the heavy burden of confusion will be removed from you forever. The stock market is not difficult to follow if you can read charts correctly, as a top professional would. You’ll understand exactly how to recognise the definitive moments of market action, and the sorts of pre- emptive signs to look out for, just before a market rises or falls. You’ll know how a bull market is created, and also the cause of a bear market. Most of all you will begin to understand how to make money from your new-found knowledge. The markets are certainly complex – so complex, in fact, that it has been seriously suggested that they move at random. Certainly, there is a suggestion of randomness in the appearance of the charts, irrespective of whether you are looking at stocks or commodities. I suspect however, that those who describe market activity as ‘random’ are simply using the term loosely, and what they really mean is that movements are chaotic. Chaos is not quite the same thing as randomness. In a chaotic system there may be hundreds, or even thousands of variables, each having a bearing on the other. Chaotic systems may appear unpredictable, but as computing technology advances, we will start to find order, where before we saw randomness. Without doubt, it is possible to predict the movements of the financial markets, and as technology advances, we will become better at it. There is an enormous gulf between unpredictability and randomness. Unless you have some idea of the various causes and effects in the markets, you will undoubtedly, and frequently, be frustrated in your trading. Why did your favourite technical tool, which worked for months, not work "this time" when it really counted? How come your very accurate and detailed fundamental analysis of the performance of XYZ Industries failed to predict the big slide in price two days after you bought 2,000 shares in it? The stock market appears confusing and complicated, but it is most definitely based on logic. Like any other free market place, prices in the financial markets are controlled by supply and demand – this is no great secret. However, the laws of supply and demand, as observed in the markets, do not behave as one would expect. To be an effective trader, there is a great need to understand how supply and demand can be interpreted under different market conditions, and how you can take advantage of this knowledge. This book will help you to do this – read on…Master the Markets 12

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What is the Market? Every stock market is comprised of individual company shares that are listed on an exchange. These markets are composed of hundreds or thousands of these instruments, traded daily on a vast scale, and in all but the most thinly traded markets, millions of shares will change hands every day. Many thousands of individual deals will be done between buyers and sellers. All this activity has to be monitored in some way. Some way also has to be found to try and gauge the overall performance of a market. This has led to the introduction of market indices, like the Dow Jones Industrial Average (DJIA) and the Financial Times Stock Exchange 100 Share Index (FTSE100). In some cases the Index represents the performance of the entire market, but in most cases the Index is made up from the "high rollers" in the market where trading activity is usually greatest. In the case of the FTSE100, you are looking at one hundred of the strongest leading companies shares, weighted by company size, then periodically averaged out to create an Index. These shares represent an equity holding in the companies concerned and they are worth something in their own right. They therefore have an intrinsic value as part-ownership of a company which is trading. The first secret to learn in trading successfully (as opposed to investing), is to forget about the intrinsic value of a stock, or any other instrument. What you need to be concerned with is its perceived value - its value to professional traders, not the value it represents as an interest in a company. The intrinsic value is only a component of perceived value. This is a contradiction that undoubtedly mystifies the directors of strong companies with a weak stock! From now on, remember that it is the perceived value which is reflected in the price of a stock, and not, as you might expect, its intrinsic value. We shall return to this later, when looking at the subject of stock selection. Have you ever wondered why the FTSE100 Index (or any other index) has generally shown a more or less continuous rise since it was first instigated? There are many contributory factors: inflation, constant expansion of the larger corporations and long-term investment by large players; but the most important single cause is the simplest and most often overlooked – the creators of the Index want it to show the strongest possible performance and the greatest growth. To this end, every so often they will weed out the poor performers and replace them with up-and-coming strong performers.Master the Markets 13

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The Market Professionals In any business where there is money involved and profits to make, there are professionals. We see professional diamond merchants, professional antique and fine art dealers, professional car dealers and professional wine merchants, among many others. All these people have one thing in mind; they need to make a profit from a price difference to stay in business. The financial markets are no different and professional traders are also very active in the stock and commodity markets – these people are no less professional than their counterparts in other areas. Doctors are collectively known as professionals, but in practice they split themselves up into specialist groups, focusing on a particular field of medicine – professional market traders do the same and also specialise in various areas. It’s important to realise at this stage, that when we refer to the definition of a professional, we are not talking about the ‘professionals’ who run your investment fund or pension. At the time of writing this section (June 2003), the vast majority of investment funds have been making huge losses for the last 4 years! Furthermore, some of these investment fund companies (including insurance firms) have even closed down, owing to their inability to invest wisely in the markets. People nearing retirement are extremely worried, as the value of their pension plummets further into the doldrums – some pension companies have even been reported to be teetering on the brink of financial crisis. In the UK, the vast majority (if not all) of the endowment funds are in trouble, even failing to make meagre returns of 6%, which means that most homeowners are now at serious risk of not being able to raise funds to pay for their homes. The ‘professionals’ in the previous examples do not live by their trading talents, instead they receive a salary from the respective investment or pension fund company – which is just as well, since these people would otherwise be homeless! I make no apology for these scathing comments, since millions of people have been adversely affected on a global scale, and billions of dollars have been lost to the witless idiots who have been given the responsibility of investing your hard-earned money. The truth of the matter is that most fund managers find it difficult to make profits unless there is a raging bull market. So what do I mean by a professional trader? Well, one example is the private syndicate traders that work in co-ordinated groups to accumulate (buy), or distribute (sell), huge blocks of stock to make similarly huge profits. You can be absolutely certain that these traders have made more money from distributing stock in the last four years, than they did during the bull market in the 1980s. Why? Because we have just witnessed one of the best moneymaking periods in your lifetime – the largest fall in stock prices for decades…Master the Markets 14

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A Special Word About Market-Makers It is important to understand that the market-makers do not control the market. They are responding to market conditions and taking advantage of opportunities presented to them. Where there is a window of opportunity provided by market conditions – panic selling or thin trading – they may see the potential to increase profits through price manipulation, but they can only do so if the market allows them to. You must not therefore assume that market-makers control the markets. No individual trader or organisation can control any but the most thinly traded of markets for any substantial period of time. Market-makers are fully aware of the activities of trading syndicates and other professional operators that place substantial orders. It therefore makes sense that they will take whatever opportunity is available to better their own accounts accordingly.Master the Markets 15

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Volume – The Key to the Truth Volume is the major indicator for the professional trader. You have to ask yourself why the members of the self-regulated Exchanges around the world like to keep true volume information away from you as far as possible. The reason is because they know how important it is in analysing a market! The significance and importance of volume appears little understood by most non-professional traders. Perhaps this is because there is very little information and limited teaching available on this vital part of technical analysis. To use a chart without volume data is similar to buying an automobile without a gasoline tank. Where volume is dealt with in other forms of technical analysis, it is often viewed in isolation, or averaged in some way across an extended timeframe. Analysing volume, or price for that matter, is something that cannot be broken down into simple mathematical formulae. This is one of the reasons why there are so many technical indicators – some formulas work best for cyclic markets, some formulas are better for volatile situations, whilst others are better when prices are trending. Some technical indicators attempt to combine volume and price movements together. This is a better way, but rest assured that this approach has its limitations too, because at times the market will go up on high volume, but can do exactly the same thing on low volume. Prices can suddenly go sideways, or even fall off, on exactly the same volume! So, there are obviously other factors at work. Price and volume are intimately linked, and the interrelationship is a complex one, which is the reason TradeGuider was developed in the first place. The system is capable of analysing the markets in real-time (or at the end of the day), and displaying any one of 400 indicators on the screen to show imbalances of supply and demand. Urban Myths You Should Ignore There are frequent quotes on supply and demand seen in magazines and newspapers, many of which are unintentionally misleading. Two common ones run along these lines. • "For every buyer there has to be a seller" • "All that is needed to make a market is two traders willing to trade at the correct price" These statements sound so logical and straightforward that you might read them and accept them immediately at face value, without ever thinking about the logical implications! You are left with the impression that the market is a very straightforward affair, like a genuine open auction at Sothebys perhaps. However, these are in fact very misleading statements. Yes, you may be buying today and somebody may be willing to sell to you. However, you might be buying only a small part of large blocks of sell orders that may have been on the market-makers books, sitting there, well before you arrived on the scene. These sell orders are stock waiting to be distributed at certain price levels and not lower.Master the Markets 16

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The market will be supported until these sell orders are exercised, which once sold will weaken the market, or even turn it into a bear market. So, at important points in the market the truth may be that for every share you buy, there may be ten thousand shares to sell at or near the current price level, waiting to be distributed. The market does not work like a balanced weighing scale, where adding a little to one scale tips the other side up and taking some away lets the other side fall. It is not nearly so simple and straightforward. You frequently hear of large blocks of stock being traded between professionals, bypassing what appears to be the usual routes. My broker, who is supposedly "in the know", once told me to ignore the very high volume seen in the market that day, because most of the volume was only market-makers trading amongst themselves. These professionals trade to make money and while there may be many reasons for these transactions, whatever is going on, you can be assured one thing: It is not designed for your benefit. You should certainly never ignore any abnormal volume in the market. In fact, you should also watch closely for volume surges in other markets that are related to that which you are trading. For example, there may be sudden high volume in the options market, or the futures market. Volume is activity! You have to ask yourself, why is the ‘smart money’ active right now?Master the Markets 17

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Further Understanding Volume Volume is not difficult to understand once the basic principles of supply and demand are understood. This requires you to relate the volume with price action. Volume is the powerhouse of the stock market. Start to understand volume and you will start to trade on facts (not on ‘news’). Your trading will become exciting as you start to realise that you can read the market – a very precious skill that only a few people share. To say that the market will go up when there is more buying (demand) than selling – and go down when there is more selling (supply) than buying may seem like an obvious statement. However, to understand this statement you need to look at the principles involved. To understand what the volume is saying to you, you have to ask yourself again, “What has the price done on this volume”? The price spread is the difference between the highest and lowest trading points reached during the timeframe you are looking at, which may be weekly, daily, hourly, or whatever other timeframe you choose. Volume shows the activity of trading during a specific period. If the volume is taken in isolation it means very little – volume should be looked at in relative terms. Therefore, if you compare todays volume with volume during the previous thirty days (or bars) it is easy to see if todays volume is high, low or average compared to the volume seen in the past. If you stand thirty people in a line, it is easy for you to see who the tall ones are, compared to the others. This is a skill of human observation, so you will have no problems identifying whether the volume is relatively high, low or average. Compare this volume information with the price spread and you will then know how bullish or bearish the professional wholesalers really are. The more practice you have, by taking this professional approach, the better you will become. To make it easier for you to understand volume, compare it to the accelerator of your automobile. Think about the results you would expect from pressing the accelerator when approaching ‘resistance’, such as a hill. Imagine you are an engineer monitoring a cars performance by remote control. Your instruments only allow you to see the power applied to the accelerator pedal (volume) and a second engineer is looking at the cars actual motion (price movement). The second engineer informs you that the car is moving forward uphill; however, this uphill movement is not in keeping with your observation of power to the accelerator pedal, which you observe is very low. You would naturally be somewhat sceptical, as you know a car cannot go uphill without sufficient power being applied. You may conclude that this movement uphill could not possibly be a genuine lasting movement, and that it is probably caused by some reason other than power application. You may even disbelieve what your instruments are telling you, as it is obvious that cars cannot travel uphill unless power is applied to the accelerator pedal. Now you are thinking more like a professional trader! Many traders are mystified if the same thing happens in the stock market. Remember, any market, just like an automobile, has ‘momentum’ that will cause movement even when the power has been turned off. This example explains why markets can momentarily rise on a low volume up-move. However, all moves with differing types of volume activity can be explained using the “accelerator pedal” analogy. Footnotes: When observing volume information, keep in mind that this represents the amount of professional activity and little else.Master the Markets 18

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What is Bullish & Bearish Volume? There are only two basic definitions for bullish and bearish volume: 1. Bullish volume is increasing volume on up-moves and decreasing volume on down-moves. 2. Bearish volume is increasing volume on down-moves and decreasing volume on up-moves. Knowing this is only a start and in many cases, not a great deal of help for trading. You need to know more than this general observation. You need to look at the price spread and price action in relation to the volume. Most technical analysis tools tend to look at an area of a chart rather than a trading point. That is, averaging techniques are used to smooth what is seen as noisy data. The net effect of smoothing is to diminish the importance of variation in the data flow and to hide the true relationship between volume and the price action, rather than highlighting it! By using the TradeGuider software, volume activity is automatically calculated and displayed on a separate indicator called the ‘Volume Thermometer’. The accuracy of this leaves you in no doubt that bullish volume is expanding volume on up-bars and decreasing volume on down-bars. The market is an on-going story, unfolding bar by bar. The art of reading the market is to take an overall view, not to concentrate on individual bars. For example, once a market has finished distributing, the ‘smart money’ will want to trap you into thinking that the market is going up. So, near the end of a distribution phase you may, but not always, see either an up-thrust (see later) or low volume up-bars. Both of these observations mean little on their own. However, because there is weakness in the background, these signs now become very significant signs of weakness, and the perfect place to take a short position. Any current action that is taking place cannot alter the strength or weakness that is embedded (and latent) in the background. It is vital to remember that near background indications are just as important as the most recent. As an example, you do exactly the same thing in your life. Your daily decisions are based on your background information and only partly on what is happening today. If you won the lottery last week, yes, you might be buying a yacht today, but your decision to buy a yacht today will be based on your recent background history of financial strength appearing in your life last week. The stock market is the same. Today’s action is heavily influenced by recent background strength or weakness, rather than what is actually happening today (this is why news does not have a long-term effect). If the market is being artificially marked up, this will be due to weakness in the background. If prices are being artificially marked down, it will be due to strength in the background. Footnotes: Down-bars: If prices are dropping on volume that is less than the previous two bars (or candles), especially if spreads are narrow, with the price closing in the middle or high of the bar, this indicates that there is ‘no selling pressure’. Up-bars: Weakness manifests itself on up-bars, especially when spreads are narrow, with volume less than the previous two bars (or candles). This shows that there is ‘no demand’ from professional traders.Master the Markets 19

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Accumulation & Distribution Syndicate traders are very good at deciding which of the listed shares are worth buying, and which are best left alone. If they decide to buy into a stock, they are not going to go about it in a haphazard or half-hearted fashion. They will first plan and then launch, with military precision, a co-ordinated campaign to acquire the stock – this is referred to as accumulation. Similarly, a co-ordinated approach to selling stock is referred to as distribution. Accumulation To accumulate means to buy as much of the stock as possible, without significantly putting the price up against your own buying, until there are few, or no more shares available at the price level you have been buying at. This buying usually happens after a bear move has taken place in the stock market (which will be reflected by looking at the Index). To the syndicate trader, the lower prices now look attractive. Not all of the issued stock can be accumulated straight away, since most of the stock is tied up. For example, banks retain stock to cover loans, and directors retain stock to keep control in their company. It is the floating supply that the syndicate traders are after. Once most of the stock has been removed from the hands of other traders (ordinary private individuals), there will be little, or no stock left to sell into a mark-up in price (which would normally cause the price to drop). At this point of ‘critical mass’, the resistance to higher prices has been removed from the market. If accumulation has taken place in lots of other stocks, by many other professionals, at a similar time (because market conditions are right), we have the makings of a bull market. Once a bullish move starts, it will continue without resistance, as the supply has now been removed from the market. Distribution At the potential top of a bull market, many professional traders will be looking to sell stock bought at lower levels to take profits. Most of these traders will place large orders to sell, not at the current price available, but at a specified price range. Any selling has to be absorbed by the market-makers, who have to create a market’. Some sell orders will be filled immediately, some go, figuratively, onto the books‘. The market- makers in turn have to resell, which has to be accomplished without putting the price down against their own, or other traders’ selling. This process is known as distribution, and it will normally take some time for the process to complete. In the early stages of distribution, if the selling is so great that prices are forced down, the selling will stop and the price will be supported, which gives the market-maker, and other traders, the chance to sell more stock on the next wave up. Once the professionals have sold most of their holdings, a bear market starts, because markets tend to fall without professional support.Master the Markets 20

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Strong & Weak Holders The stock market revolves around the simple principles of accumulation and distribution, which are processes that are not well known to most traders. Perhaps you can now appreciate the unique position that the market-makers, syndicate traders, and other specialist traders are in – they can see both sides of the market at the same time, which represents a significant advantage over the ordinary trader. It is now time to refine your understanding of the stock market, by introducing the concept of ‘Strong and Weak Holders.’ Strong Holders Strong holders are usually those traders who have not allowed themselves to be trapped into a poor trading situation. They are happy with their position, and they will not be shaken out on sudden down-moves, or sucked into the market at or near the top. Strong holders are strong because they are trading on the right side of the market. Their capital base is usually large, and they can normally read the market with a high degree of competence. Despite their proficiency, strong holders will still take losses frequently, but the losses will be minimal, because they have learnt to close out losing trades quickly. A succession of small losses is looked upon in the same way as a business expense. Strong holders may even have more losing trades than winning trades, but overall, the profitability of the winning trades will far outweigh the combined effect of the losing trades. Weak Holders Most traders who are new to the markets will very easily become Weak Holders. These people are usually under-capitalised and cannot readily cope with losses, especially if most of their capital is rapidly disappearing, which will undoubtedly result in emotional decision-making. Weak holders are on a learning curve and tend to execute their trades on ‘instinct’. Weak holders are those traders who have allowed themselves to be locked-in as the market moves against them, and are hoping and praying that the market will soon move back to their price level. These traders are liable to be shaken out on any sudden moves or bad news. Generally, weak holders will find that they are trading on the wrong side of the market, and are therefore immediately under pressure if prices turn against them. If we combine the concepts of strong holders accumulating stock from weak holders prior to a bull move, and distributing stock to potential weak holders prior to a bear move, then in this context: • A Bull Market occurs when there has been a substantial transfer of stock from Weak Holders to Strong Holders, generally, at a loss to Weak Holders. • A Bear Market occurs when there has been a substantial transfer of stock from Strong Holders to Weak Holders, generally at a profit to the Strong Holders.Master the Markets 21

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The following events will always occur when markets move from one major trending state to another: The Buying Climax Brief Definition: An imbalance of supply and demand causing a bull market to transform into a bear market. Explanation: If the volume is seen to be exceptionally high, accompanied by narrow spreads into new high ground, you can be assured that this is a ‘buying climax’. It is called a buying climax because to create this phenomenon there has to be a huge demand for buying from the public, fund managers, banks and so on. It is into this buying frenzy, that syndicate traders and market-makers will dump their holdings, to such an extent that higher prices are now impossible. In the last phase of the buying climax, the market will be seen to close in the middle or high of the bar. The Selling Climax Brief Definition: An imbalance of supply and demand causing a bear market to transform into a bull market. Explanation: This is the exact opposite of a buying climax. The volume will be extremely high on down-moves, accompanied by narrow spreads, with the price entering fresh low ground. The only difference is that on the lows, just before the market begins to turn, the price will be seen to close in the middle or low of the bar. To create this phenomenon requires a huge amount of selling, such as that witnessed following the tragic events of the terrorist attacks on the World Trade Centre in New York on September the 11th 2001. Note that the above principles seem to go against your natural thinking (i.e. market strength actually appears on down-bars and weakness, in reality, appears on up-bars). Once you have learned to grasp this concept, you will be on your way to thinking much more like a professional trader.Master the Markets 22

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Resistance & Crowd Behaviour We have all heard of the term ‘resistance’, but what exactly is meant by this loosely used term? Well, in the context of market mechanics, resistance to any up-move is caused by somebody selling the stock as soon as a rally starts. In this case, the floating supply has not yet been removed. The act of selling into a rally is bad news for higher prices. This is why the supply (resistance) has to be removed before a stock can rally (rise in price). Once an up-move does take place, then like sheep, all other traders will be inclined to follow. This concept is normally referred to as ‘herd instinct’ (or crowd behaviour). As human beings, we are free to act however we see fit, but when presented with danger or opportunity, most people act with surprising predictability. It is this knowledge of crowd behaviour that helps the professional syndicate traders to choose their moment to make a large profit. Make no mistake – professional traders are predatory beasts and uninformed traders represent the symbolic ‘lamb to the slaughter’. We shall return to the concept of ‘herd instinct’ again, but for now, consider the importance of this phenomenon, and what it means to you as a trader. Unless the laws of human behaviour change, this process will always be present in the financial markets. You must always try to be aware of ‘Herd Instinct’. There are only two main principles at work in the stock market, which will cause a market to turn. Both of these principles will arrive in varying intensities producing larger or smaller moves: 1. The ‘herd’ will panic after observing substantial falls in a market (usually on bad news) and will usually follow its instinct to sell. As a trader who is aware of crowd psychology, you must ask yourself, “Are the trading syndicates and market-makers prepared to absorb the panic selling at these price levels?” If they are, then this is a good sign that indicates market strength. 2. After substantial rises, the ‘herd’ will become annoyed at missing the up-move, and will rush in and buy, usually on good news. This includes traders who already have long positions, and want more. At this stage, you need to ask yourself, “Are the trading syndicates selling into the buying?” If so, then this is a severe sign of weakness. Does this mean that the dice is always loaded against you when you enter the market? Are you destined always to be manipulated? Well, yes and no. A professional trader isolates himself from the ‘herd’ and becomes a predator rather than a victim. He understands and recognises the principles that drive the markets and refuses to be misled by good or bad news, tips, advice, brokers, or well-meaning friends. When the market is being shaken-out on bad news, he is in there buying. When the ‘herd’ is buying and the news is good, he is looking to sell.Master the Markets 23

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You are entering a business that has attracted some of the sharpest minds around. All you have to do is to join them. Trading with the ‘strong holders’ requires a means to determine the balance of supply and demand for an instrument, in terms of professional interest, or lack of interest, in it. If you can buy when the professionals are buying (accumulating or re-accumulating) and sell when the professionals are selling (distributing or re-distributing) and you do not try to buck the system you are following, you can be as successful as anybody else can in the market. Indeed, you stand the chance of being considerably more successful than most!Master the Markets 24

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Supply & Demand We can learn a great deal from observing the professional market operators. If you watch a top professional trading and he is not on the floor, he will most likely be looking at a trading screen, or a live chart on a computer screen. On the face of it, his resources are no different from any other trader. However, he does have information on the screen you are not privileged to see. He knows where all the stops are, he knows who the large traders are and whether they are buying or selling. He has low dealing costs compared to you. He is well practised in the art of trading and money management. What does he see? How does he manage to get a good position when, by the time you get to the market, prices always seem to be against your interests? How does such a trader know when the market is going to move up or down? Well, he understands the market and uses his knowledge of volume and price action as his primary cues to enter (or exit) the market. His primary concern is the state of supply and demand of those instruments in which he has an interest. One way or another, the answers lie in some form of analysis of trading volume, price action and price spreads. Here at TradeGuider Systems Ltd, we have developed a methodology called Volume Spread Analysis (abbreviated to VSA), which has been built into the computer model that is utilised in the TradeGuider software. Learning which questions to ask and how to obtain the answers requires us to look more deeply into the markets. The stock market becomes far more interesting if you have some idea what is going on and what is causing it to go up or down. A completely new and exciting world can open up for you. Nearly all traders use computers and many of these traders are using Technical Analysis packages. They will have learned how to use well-known indicators, like RSI and Stochastics, which are mathematical formulae based on a historical study of price. Some packages have over 100 indicators and other tools that measure cycles, angles, or retracements. There is even software that analyses the effects of tidal forces, astrological, planetary, and galactic influences. To many traders, these methods will have a place in their trading decisions, because they will be familiar with their use. However, it can become a very frustrating business being placed outside of the market looking in, using these tools, trying to decide if the market is likely to go up or down. The fact is, these tools never tell you why the market is moving either up or down – that, in most cases remains a complete mystery. People, unless they are naturally well disciplined, are extremely open to suggestion! Folks like to be given tips, listen to the news stories, seek out rumours in internet chat rooms, or maybe subscribe to secret information leaked from unknown sources. For the most part, professional floor traders, syndicate traders, and the specialists, do not look at these things. They simply do not have the time. Professionals have to act swiftly, as soon as market conditions change, because they are up against other professionals who will act immediately against their interests if they are too slow in reacting to the market. The only way they can respond that fast is to understand and react, almost instinctively, to what the market is telling them. They read the market through volume and its relationship to price action. You, too, can read the market just as effectively, but you have to know what you are looking at, and what you are looking for.Master the Markets 25

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The Basics of Market Reading Before you can start your analysis, you will need to see all the relevant price action, going back over the past few months. We recommend using the TradeGuider software, by TradeGuider Systems Ltd (www.TradeGuider.com), since using this software will give you a significant advantage over standard charting software, as you will also be able to see our proprietary VSA indicators. There are around 400 indicators built into TradeGuider, which utilise all the introductory principles in this brief book, plus the many other advanced VSA indicators that we have developed and researched over the course of the last 15 years. Chart 1: A typical bar chart (chart courtesy of TradeGuider) A price chart is simply a visual representation of price movement over a specified period. The most common time period that investors and traders use is the daily chart, where each ‘bar’ represents a single day. Intraday traders (i.e. real-time) use charts with much smaller timeframes, such as 1 and 2 minutes. Each price bar shows the high (top of bar), low (bottom of bar), and closing price (notch on the right side of the bar).Master the Markets 26

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Volume is usually shown as a histogram on the bottom of the chart. We recommend that you don’t use the open interest volume, since this can be misleading. However, for real-time charts, tick volume may be used where no transaction volume is available. At this point, it is important to note that volume gives us an indication of the amount of activity that has taken place during whichever timeframe is being monitored. All markets move in ‘phases’; we can observe the market building a cause for the next move. These phases vary – some last only a few days, some several weeks. The longer phases give rise to large moves, and the shorter phases result in smaller moves. The amount of volume taken in isolation means little – it is the relative volume we are interested in. The chart below shows the relative volume indicator that is unique to TradeGuider. It is showing that there is considerably more bearish volume in the market, which is why the prices decline on this chart. Once you have established the relative volume of business, you must consider how the market responds to this activity. Chart 2: The relative volume indicator (chart courtesy of TradeGuider) The spread is the range from the high to the low of the price bar. We are particularly interested in whether the spread is abnormally wide, narrow, or just average. The TradeGuider software interprets the spread size, and all other relevant information for you, so there is no need to establish anything by eye (which can be difficult at times). The graphic below shows how TradeGuider reports all the required information with easily comprehensible English words, rather than arbitrary numerical values.Master the Markets 27

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How to Tell if a Market is Weak or Strong Buy and sell orders from traders around the world are generally processed and matched up by market- makers. It is their job to create a market. In order to create a market they must have large blocks of stocks to trade with. If they do not have sufficient quantities on their books to trade at the current price level, they will have to move quickly to another price level where they do have a holding, or call on other market- makers for assistance. All market-makers are in competition with each other for your business, so their response to your buy or sell order has to be realistic and responsive to market conditions. If the market has been in a bull-move and you place a buy order into a rising market, you may receive what appears to be a good price from the floor of the exchange. Why are you receiving a good price? Have these hard-nosed professionals decided that they like you and have decided to be generous giving away some of their profits to you? Or have they now decided to start switching positions, taking a bearish or negative view of the market, because their books have started to show large sell orders to dispose of? Their perceived value of the market or stock may be lower than yours because they expect prices to fall or at best go sideways. Such action, repeated many times across the floor, will tend to keep the spread of the day narrow, by limiting the upper end of the price spread, because they are not only giving you what appears to be a good price, but also every other buyer. If, on the other hand, the market-maker has a bullish view, because he does not have large sell orders on his books, he will mark-up the price on your buy order, giving you what appears to be a poor price. This, repeated, makes the spread wider as the price is constantly marked up during the day. So by simple observation of the spread of the bar, we can read the sentiment of the market-makers; the opinion of those who can see both sides of the market. Frequently, you will find that there are days where the market gaps up on weakness. This gapping up is far different from a wide spread up, where the market-makers are marking the prices up against buying. The gapping up is done rapidly, usually very early in the days trading, and will certainly have emotional impact. This price action is usually designed to try to suck you into a potentially weak market and into a poor trade, catching stop-losses on the short side, and generally panicking traders to do the wrong thing. You will find that weak gap-ups are always into regions of new highs, when news is good and the bull market looks as though it will last forever.Master the Markets 28

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You can observe similar types of gapping-up action in strong markets too, but in this second case you will have an old (sideways) trading area to the left. Traders who have become trapped within the channel (sometimes referred to as a ‘trading range’), either buying at the top and hoping for a rise, or buying at the bottom and not seeing any significant upwards price action, will become demoralised at the lack of profit. These locked-in traders want only one thing – to get out of the market at a similar price to the one they first started with. Professional traders that are still bullish know this. To encourage these old locked-in traders not to sell, professional traders will mark-up , or gap up the market, through these potential resistance areas as quickly as possible. Chart 3: Locked-in traders (chart courtesy of TradeGuider) Here you can see that prices have been rapidly marked up by professional traders, whose view of the market at that moment is bullish. We know this because the volume has increased, substantially backing up the move. It cannot be a trap up-move, because the volume is supporting the move. Wide spreads up are designed to lock you out of the market rather than attempting to suck you in. This will tend to put you off buying, as it goes against human nature to buy something today that you could have bought cheaper yesterday, or even a few hours earlier. This also panics those traders that shorted the market on the last low, usually encouraged by the timely release of ‘bad news’, which always seems to appear on, or near, the lows. These traders now have to cover their short position (buying), adding to the demand. Note from the above chart that the volume shows a substantial and healthy increase – this is bullish volume. Excessive volume, however, is never a good sign; this indicates ‘supply’ in the market, which is liable to be swamping the demand. However, low volume warns you of a trap up-move (which is indicative of a lack of demand in the market).Master the Markets 29

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If you take the rapid up-move in isolation, all it shows is a market that is going up. What brings it to life is the trading range directly to the left. You now know why it is being rapidly marked up, or even gapped-up. Also note that any low volume down-bars which appear after the prices have rallied and cleared the resistance to the left, is an indication of strength and higher prices to come. Specialists and market-makers base their bids and offers on information you are not privileged to see. They know of big blocks of buy or sell orders on their books at particular price levels and they are also fully in tune with the general flow of the market. These wholesalers of stocks also trade their own accounts. It would be naïve to think they are not capable of temporarily marking the market up or down as the opportunity presents itself, trading in the futures or options markets at the same time. They can easily mark the market up or down on good or bad news, or any other pretence. They are not under the severe trading pressures of normal traders, because they are aware of the real picture, and in the most part, it is they who are doing all the manipulating. This is good news for us because we can see them doing this, in most cases fairly clearly, and can catch a good trade if we are paying attention. Why play around with the prices? Well, the market-makers want to trap as many traders as possible into poor positions. An extra bonus for them includes catching stop-loss orders, which is a lucrative business in itself. Owing to the huge volume of trading in the markets, it will take professional buying or selling to make a difference that is large enough for us to observe. This fact alone tells us that there are professionals working in all the markets. These traders, by their very nature, will have little interest in your financial well-being. In fact, given the slightest opportunity, the ‘smart money’ can be regarded as predators looking to catch your stops and mislead you into a poor trade.Master the Markets 30

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How to Identify Buying & Selling For a market to move up you need buying, which is generally seen on an up-bar (i.e. the present bar closes higher than the previous bar). The amount of volume attached to the up-bar should be increasing in volume. However, this increase in volume should not be excessive, as this is indicative of supply in the background that is swamping the demand. If you observe that the volume is low as the market moves up, you know this has to be a false picture. This low volume is caused by the professional money refusing to participate in the up-move, usually because they know the market is weak. The market may be moving up, but it does not have the participation of the traders that matter. Unless the ‘smart money’ is interested in the move, it is certainly not going to rise very far. During a bear market, you will frequently see temporary up-moves on low volume. The reason for the up- move is of no concern to us, but we see a market that is bearish going up on low volume. This can only happen because the professional money is not interested in higher prices and is not participating, hence the low volume. The professionals are bearish and have no intention of buying into a weak market just because it happens to be going up. If this action is seen with a trading range to the left, at the same price level, this becomes a very strong indication of lower prices to follow. The opposite is also true for down-moves. So, for a legitimate down-move you would need to witness evidence of selling, which would reveal itself as increased volume on down-bars (i.e. the present bar closes lower than the previous bar). If you see an increase in volume that is excessive, then you should be wary, as this may indicate that demand is in the background. If you begin to notice the volume drying up on down-bars, this is evidence that the amount of selling pressure is reducing. The market may continue to fall, but be aware that it could quickly turn and rise momentarily, due to the lack of supply. A decreasing amount of volume on any down-bar indicates that there is no professional interest to the downside.Master the Markets 31

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How to Identify Lack of Demand ‘Lack of demand’ is one of the most common indications you will see and it is pretty easy to pick out. Basically, you will be watching out for a low volume up-bar, on a narrow spread, such as the one identified by TradeGuider in the chart below. Chart 4: No demand (chart courtesy of TradeGuider) If, over the next few bars or more, the price closes down, on declining volume, with narrow spreads, then this indicates that there is no selling pressure. In this case, we have observed some temporary weakness, which has now been overcome – the up-move may now continue. Whilst reading a chart, try to keep in mind that most people fail to link human behaviour (in this case, of professional traders) with the price spreads and the volume, but would rather believe the mass of incoming news, which inevitably differs from what supply and demand is telling you.Master the Markets 32

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Chart 5: Market goes flat on No demand (chart courtesy of TradeGuider) It is the lack of demand from professional money that causes a market to roll over at the tops, resulting in the characteristic mushroom shape. You will not notice this weakness because the news will still be good. The chart above shows a market that is completely devoid of professional support. All the Xs on the chart show narrow spread bars that are closing higher than the previous bar, on low volume. There is absolutely no way a market can rally up through an old trading top, and into fresh new ground on this lack of demand. Do not view lack of demand in isolation – try to take a holistic view when reading the market. You should always look to the background. What are the previous bars telling you? If you have the TradeGuider software, this will help you to become a better trader by teaching you how to read the markets. In time, you will become more proficient at market analysis, such that you may even decide to trade ‘blind’, to test your skills without the supply and demand indicators built into the software. For now, remember that we need confirmation before shorting the market following any sign of no demand. There are many confirming indicators built into the software, but suffice to say that this sometimes appears as a narrow spread up-bar on greatly increased volume. In this instance, professional traders have started to transfer stock to eager uninformed (or misinformed!) buyers. Prices are being kept low to encourage buying, which accounts for the narrow spread. These traders are completely unaware of the implications of volume activity and are probably buying on repeated ‘good news‘.Master the Markets 33

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Testing Supply Testing is by far the most important of the low volume buy signals. As we shall refer to the subject many times, in what follows, it will be worthwhile to digress here for a moment and look at the subject in detail. What is a "test" and why do we place such importance on this action? A large trader who has been accumulating an individual stock or a section of the market can mark prices down with some confidence, but he cannot mark prices up when others are selling into the same market without losing money. To attempt to mark prices up into selling is extremely poor business, so poor in fact, it will lead to bankruptcy if one persists. The danger to any professional operator who is bullish, is supply coming into his market (selling), because on any rally, selling on the opposite side of the market will act as resistance to the rally and may even swamp his buying. Bullish professionals will have to absorb this selling if they want higher prices to be maintained. If they are forced to absorb selling at higher levels (by more buying), the selling may become so great that prices are forced down. They will have been forced to buy stock at an unacceptably high level and will lose money if the market falls. Rallies in any stock-based indices are usually short-lived after you have seen supply in the background. The professional trader knows that given enough time (with bad news, persistent down-moves, even time itself with nothing much happening) the floating supply can be removed from the market, but he has to be sure the supply has been completely removed before trying to trade up his holding. The best way to find out is to rapidly mark the prices down. This challenges any bears around to come out into the open and show their hand. The amount of volume (activity) of trading as the market is marked down will tell the professional how much selling there is. Low volume, or low trading activity, shows there is little selling on the mark-down . This will also catch any stops below the market, which is a way of buying at still lower prices. (This action is sometimes known as a springboard) High volume, or high activity, shows that there is in fact selling (supply) on the mark-down . This process is known as testing. You can have successful tests on low volume and other types of tests on high volume, usually on ‘bad news‘. This not only catches stops, but shakes the market out as well, making the way easier for higher prices. Testing is a good sign of strength (as long as you have strength in the background). Usually, a successful test (on low volume) tells you that the market is ready to rise immediately, whilst a higher volume test usually results in a temporary up-move, and will be subject to a re-test of the same price area again at a later time. This action sometimes results in a “W” shape. This pattern is sometimes referred to as a “dead cat bounce” or a “double bottom”. The “W” shape results from the action of re-testing an area that had too much supply before.Master the Markets 34

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Chart 6: Testing Supply (chart courtesy of TradeGuider) Above is a chart that shows a valid test. Any down-move dipping into an area of previous selling (previous high volume level), which then regains to close on, or near the high, on lower volume, is a loud and clear indication to expect higher prices immediately. This is a successful test. Lower volume shows that the amount of trading that took place on the mark-down was reduced, that now there is little selling, when previously there had been selling. At this point, it is now important to see how the market-makers and specialists respond to the apparent strength seen in the testing. If you are in a bearish or weak market, you may see at times, what appears to be a test. However, if the market does not respond to what is normally an indication of strength, then this shows further weakness. The specialist or market-maker is never going to fight the market. If, in his view, the market is still weak on these days, he will withdraw from trading. The market will then be reluctant to go up, even if it looks as if it should go up, because there was little or no selling on the ‘test’ day. Any testing that does not respond immediately with higher prices, or certainly during the next day or so, can be considered an indication of weakness. If it were a true sign of strength, the specialists or market- makers would have stepped in and would be buying the market – the result of this professional support would be the beginnings of an upward trending market.Master the Markets 35

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Pushing Up Through Supply Let us return to look more closely at what happens when professional money pushes up through a potential area of supply. Old trading ranges form resistance areas, because it is a known supply level. Human behaviour will never change and the actions of the herd are well documented. Of the traders that had been buying into the market within the old trading area, many are still in there and have been locked-in by a down-move – the chart below illustrates this. The main concern for these locked-in traders is to sell and recover as much as they can, hopefully without losses. As such, they represent potential supply (resistance) to the market. Chart 7: Pushing up through Supply (chart courtesy of TradeGuider) The market-makers know exactly where these resistance areas are. If they are bullish, and higher prices are anticipated, the market-maker will certainly want a rally. The problem now is how to avoid being forced to buy stock from these locked-in traders at what, to them, may appear to be high prices.Master the Markets 36

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Any supply area can be compared to the frequent and hated toll gates placed across roads in olden days. Your progress was constantly impeded by having to stop and pay your toll fee if you wanted to go further. In the stock market, higher prices are frequently blocked by a variety of traders who already hold poor trading positions and want to sell. If the specialists or market-makers are expecting higher prices they will have to pay their toll by absorbing any selling from these traders, but they will try and avoid or limit this toll fee by all means. So how do the market-makers cope with this problem? A rapid, wide spread, or gapping, up through an old area of supply as quickly as possible, is an old and trusted method. To the informed trader, we now have a clear sign of strength. The stock specialist does not want to have to buy stock at high prices. He has already bought his main holding at lower levels. Therefore, the locked-in traders must be encouraged not to sell. As the market approaches the area at which the locked-in traders could sell out without a loss, the price rockets, gapping up, or shooting up on a wide spread. This phenomenon can be seen on the previous chart. The locked-in traders who have been concerned over potential losses will now suddenly be showing a profit and will be tempted not to sell as the stress of a potential loss now turns to elation. As these traders allowed themselves to be trapped in the first place, it is liable to happen to them again at even higher prices. Gapping up and through resistance on wide spreads is a tried and tested manoeuvre by market-makers and specialists to limit the amount of stock having to be bought to keep the rally going – a way of avoiding the toll gates. The example on the above chart is on a daily timeframe, but these principles will appear on any chart because this is the way professional traders behave. If you observe high volume accompanying wide spreads up, this shows that the professional money was prepared to absorb any selling from those locked-in traders who decided to sell – this is known as absorption volume. In this situation, the market-makers anticipate higher prices and are bullish. They know that a breakout above an old trading area will create a new wave of buying. In addition, those traders who have shorted the market will now be forced to cover their poor positions by buying as well. Furthermore, traders that are looking for breakouts will buy. Finally, all those traders not in the market may feel they are missing out and will be encouraged to start buying. This all adds to the professional bullish positions. If you see any testing or down-bars on low volume after this event, it is a very strong buy signal.Master the Markets 37

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High Volume on Market Tops Many newspaper journalists and television reporters assume that when the market hits new highs on high volume, that this is buying and a continuation of the up-move (the news is ‘good’ and everybody is bullish). This is a very dangerous assumption. As we have already touched upon during this text, high volume on its own is not enough. If the market is already in a rally and high volume suddenly appears during an up-day (or bar) and immediately the market starts to move sideways or even falls next day, then this is a key indicator of a potential end to the rally. If the higher volume shows an increased effort to go up, we would expect the extra effort to result in higher prices. If it does not, then there must have been something wrong. This principle is known as effort versus results and we will cover this in more detail later. A high volume up-day into new high ground with the next day level or down is an indication of weakness. If the high volume had shown professional buying, how can the prices not go on up? This action shows that buying has come into the market, but be warned that the buying has most likely come from potential weak holders who are being sucked into a rally top! It happens all the time. Chart 8: A rally fails on very high volume (chart courtesy of TradeGuider) Footnotes: If there is no professional interest to the upside, the market will fall, or at best, go sideways.Master the Markets 38

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Effort versus Results Effort to go up is usually seen as a wide spread up-bar, closing on the highs, with increased volume – this is bullish. The volume should not be excessive, as this will show that there is also supply involved in the move (markets do not like very high volume on up-bars). Conversely, a wide spread down-bar, closing on the lows, on increased volume is bearish, and represents effort to go down. However, to read these bars on your chart, common sense must also be applied, because if there has been an effort to move, then there should be a result. The result of effort can be a positive one or a negative one. For example, on Chart 7 (pushing up through supply), we saw an effort to go up and through resistance to the left. The result of this effort was positive, because the effort to rise was successful – this demonstrates that professional money is not selling. If the additional effort implied in the higher volume and wide spreads upwards had not resulted in higher prices, we can draw only one conclusion: The high volume seen must have contained more selling than buying. Supply on the opposite side of the market has been swamped by demand from new buyers and slowed or stopped the move. This has now turned into a sign of weakness. Moreover, this sign of weakness does not just simply disappear; it will affect the market for some time. Markets will frequently have to rest and go sideways after any high volume up-days, because the selling has to disappear before any further up-moves can take place. Remember, selling is resistance to higher prices! The best way for professional traders to find out if the selling has disappeared is to ‘test’ the market – that is, to drive the market down during the day (or other timeframe) to flush out any sellers. If the activity and the volume are low on any drive down in price, the professional traders will immediately know that the selling has dried-up. This now becomes a very strong buy signal for them. Frequently, you will see effort with no result. For instance, you may observe a bullish rally in progress with sudden high volume appearing – news at this time will almost certainly be ‘good’. However, the next day is down, or has only gone up on a narrow spread, closing in the middle or even the lows. This is an indication of weakness – the market must be weak because if the high activity (high volume) had been bullish, why is the market now reluctant to go up? When reading the market, try to see things in context. If you base your analysis on an effort versus results basis, you will be taking a very sensible and logical approach that detaches you from outside influences, such as ‘news’ items, which are often unwittingly inaccurate with regards to the true reasons for a move. Remember, markets move because of the effects of professional accumulation or distribution. If a market is not supported by professional activity, it will not go very far. It is true that the news will often act as a catalyst for a move (often short-lived), but always keep in mind that it is the underlying activity of ‘smart money’ that provides the effort and the result for any sustained price movement.Master the Markets 39

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The Path of Least Resistance The following points represent the path of least resistance: • If selling has decreased on any down-move, the market will then want to go up (no selling pressure). • If buying has decreased on any up-move, the market will want to fall (no demand), Both these points represent the path of least resistance. • It takes an increase of buying, on up-days (or bars), to force the market up. • It takes an increase of selling, on down-days (or bars), to force the market down. • No selling pressure (no supply) indicates that there is not an increase in selling on any down-move. • No demand (no buying), shows that there is little buying on any up-move. Bull moves run longer than bear moves because traders like to take profits. This creates a resistance to up- moves. However, you cannot have a bear market develop from a bull market until the stock bought on the lows has been sold (distributed). Resistance in a bull move represents selling. The professional does not like to have to keep buying into resistance, even if he is bullish. He also wants to take the path of least resistance. To create the path of least resistance he may have to gap-up, shake-out, test, and so on, or he may do nothing at that moment, allowing the market to just drift. Bear markets run faster than bull markets because a bear market has no support from the major players. Most traders do not like losses and refuse to sell, hoping for a recovery. They may not sell until forced out on the lows. Refusing to sell and accepting small losses, the trader becomes locked-in and then becomes a weak holder, waiting to be shaken out on the lows.Master the Markets 40